GDOC - Catalent: No Catalyst Just Yet

• Catalent has built up a solid track record of value creation over the past nearly decade long period.
• The company has seen excellent operating momentum, despite the pandemic being on its retreat.
• With shares lagging, valuations have become a lot more compelling, not to be confused with an appealing entry point just yet.

Nearly a year ago I concluded that Catalent, Inc. (CTLT) was missing a catalyst after the pandemic. The company has done well on the back of organic growth, dealmaking, and the pandemic. While all of this has been applauded, the reality is that expectations had risen quite a bit as well, as I failed to see appeal at the time.

A Quick Recap

Catalent went public in August 2014. I saw relatively limited appeal at the time on the back of slow growth and an elevated debt load. Ever since, the company has executed well, having delivered on solid organic growth, while it has been able to grow into the valuation.

Catalent is a key partner for pharmaceutical and biotechnology companies, helping these customers to bring products to the markets in a faster fashion. Oral, injectable and respiratory technologies have been delivered by Catalent which levers this technology to its clients, as scale and expertise makes it a desirable option for large manufacturers which have less efficient and effective internal manufacturing processes.

The company went public at $20 per share in 2014 and was valued at $4.3 billion at the time, including a substantial leverage position. This was based on a business which generated $1.8 billion in sales on which operating profits were reported at $204 million, with all these earnings eaten by expensive interest costs. Since 2014, shares rallied in a steady fashion to $60 ahead of the pandemic as Catalent lived up to its long-term positioning.

Growth up to 2020 was driven by some deals, including a near-billion dollar deal for Cook Pharma in 2017 and a >$1 billion deal for Paragon Bioservice in 2019. These deals and organic growth made that sales rose to a run rate of nearly $3 billion in 2019, with adjusted earnings posted at $1.80 per share, as the adjustments seem quite fair.

In August 2020, the company posted its fiscal 2020 results with sales up 23% to $3.1 billion as the company actually benefited from the pandemic, with fourth quarter revenues up 31%. Net debt fell to just below 3 times, as adjusted earnings per share rose to $2.11 per share as the company was a beneficiary of the pandemic, with spectacular growth seen in its biologics segment. During 2021, it was evident that momentum was strong, with sales reported at $4.0 billion, with adjusted earnings inching up to just over $3 per share.

With shares trading at $130 in August 2021, I was naturally very cautious after 2021 earnings just topped $3 per share, resulting in a steep valuation at more than 40 times earnings. This was despite the outlook for 2022, which called for sales to rise further to $4.4 billion, with earnings seen at $3.40 per share. This confidence and reduced leverage made that the company announced a $1 billion deal for Bettera Holdings at the time.

With valuations equal to 40 times earnings while leverage was still high, I saw no reason to get involved with the shares.

What Happened?

Since my cautious tone last year, shares temporarily traded in the $140s in September, but ever since have sold off quite a bit to numbers close to $100 per share, now trading at $108 per share.

In November, the company posted strong first quarter results as it hiked the full year sales guidance by more than $300 million to a midpoint of $4.7 billion, as the adjusted EBITDA guidance was hiked by a hundred million to $1.26 billion, with smaller yet more positive updates to the full year guidance following alongside the release of the second quarter results in February.

Early in May, Catalent posted third quarter results as more updates to the outlook followed with revenues now seen at a midpoint of $4.85 billion, EBITDA seen at $1.28 billion and adjusted earnings forecasted at $685 million, or about $3.75 per share. Net debt stood at $3.6 billion, equal to about 2.6 times EBITDA. Even more promising, the company already guided for fiscal 2023 sales growth at 8-9%, even if the pandemic retreats.

With shares now trading at $108, the market value of the firm stands at $19.6 billion, or about $23 billion if we factor in net debt. Needless, to say, valuations remain demanding at 29 times, yet this is a lot lower than the 40 times multiple at this time last year. Even more so, the guidance (which calls for solid growth in 2023) is comforting, even with the pandemic on its retreat.

In August 2022, Catalent announced its next bolt-on deal as it has reached an agreement to acquire Metris Contract Services, a full-service CDMO in a $475 million deal, with few financial details announced on the contribution of this deal. With the deal tag equivalent to about 2% of the valuation of Catalent, this is not too meaningful, as leverage will be in check post the deal as well.

What Now?

With shares down $20 since this time last year and the business generally having done better than I thought, the valuation has become a lot more compelling here, yet a 29-times current multiple is not too compelling in my book. While I am not actively thinking about pursuing a position here, the risk-reward has certainly improved a great deal, not to be confused with the fact that appeal is seen here.

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